Morgan Stanley’s Profit Drops 24%

Profit at Wall Street brokerage firm Morgan Stanley fell 24% in its fiscal second quarter because of difficult market conditions and higher legal expenses in connection with high-profile lawsuits, the company said Wednesday.

Morgan Stanley also said it was still reviewing a potential spinoff of its Discover Financial Services credit card division -- a low-margin business that nonetheless provides Morgan Stanley with strong cash flow.

Shares of Morgan Stanley fell 45 cents to $50.52.

David Sidwell, Morgan Stanley’s chief financial officer, said the pending departure of Chairman and Chief Executive Philip J. Purcell, who last week bowed to pressure to leave the company from a group of disgruntled shareholders and former executives, had not affected the company’s financial status. However, he said that it had made recruitment and retention more difficult.

For the quarter ended May 31, Morgan Stanley posted earnings of $928 million, or 86 cents a share, compared with $1.22 billion, or $1.10, a year earlier. Revenue fell 9% to $6 billion from $6.8 billion last year.

The company was expected to earn 92 cents a share on $5.7 billion in revenue in the latest quarter, according to analysts surveyed by Thomson First Call.

“This quarter marked a much weaker operating environment for many of our businesses,” Sidwell said, adding that the company’s earnings were “pretty good” and measured up well against its competitors.

Morgan Stanley said its legal expenses totaled $140 million for the quarter, mostly because of settlement talks over its alleged role in the collapse of Italy’s Parmalat dairy company. A number of U.S. investment banks have been investigated in the financial scandal at the Italian company.

Morgan Stanley did not increase its $360-million legal reserve for damages awarded last month to billionaire investor Ronald Perelman. Perelman won a $1.45-billion judgment against Morgan Stanley after alleging the company did not disclose the true financial state of its client Sunbeam Corp. when Perelman invested.

Last week, other Wall Street firms, including Lehman Bros. Holdings Inc. and Bear Stearns Cos., posted strong earnings thanks to successful fixed-income trading, which includes bonds and credit trading. However, Morgan Stanley’s fixed-income sales and trading revenue fell 28% for the quarter. And the Discover division, which includes a home loan business, posted flat revenue as mortgage sales declined.

Even Morgan Stanley’s traditional strength, its investment banking business, saw a 15% decline in revenue. The company’s advisory revenue -- for aiding companies with mergers and acquisitions -- rose 10% for the quarter, even though completed M&A; transactions fell 18%.

Revenue from debt and equity underwriting, in which the firm helps corporations sell their stocks and issue bonds, fell 33% from a year earlier.

The company said it ranked first in global M&A; advising, with a 36% market share, and second in global initial public stock offerings, with a 10% market share.

Revenue for the company’s individual brokerage business rose 2% from last year, though expenses rose 3% on higher service costs. In Morgan Stanley’s investment management division, which includes the company’s mutual fund offerings, revenue fell 7% from a year earlier.

“Retail investors began their summer exodus from the equity markets early,” Sidwell said, adding that a volatile stock market, unusual bond trading and large swings in commodity prices created difficulties for the company’s proprietary trading and spooked many of its retail clients.

Looking ahead, Morgan Stanley said it would continue to analyze the possibility of a Discover spinoff into a stand-alone publicly traded company. The company announced April 4 that it would pursue a spinoff, though Purcell’s departure might postpone that move so that the company’s new leadership could make its own decision.

Purcell was roundly criticized this spring by a small but vocal group of dissident shareholders and former executives who said his leadership style was driving away the company’s talent. Five of the 14 executives on Morgan Stanley’s executive committee left the company in March and April, and a number of talented managers and traders followed. Purcell and the company’s board of directors agreed June 12 that it would be best for him to retire to prevent further harm to the firm.